Following the latest round of drivel from Donald Trump, this might be a good time to review the standard textbook case for free trade. (You’ll also find this spelled out in The Big Questions .)

Suppose American manufacturers sell 1000 widgets a year to American consumers at a price of $9 each. Now, thanks to a new free trade agreement, foreign manufacturers can sell widgets to American consumers at $6 each. Let’s try to account for all the different ways that Americans are affected.

1. American manufacturers have two choices: They can match the foreign price of $6, or they can go do something else. If they match the foreign price, they lose $3 per widget (compared to what they were making before). If instead they go do something else, they lose at most $3 per widget. We know this, because they always have the option of matching the foreign price and therefore won’t choose any option worse than that. Therefore, the loss to American manufacturers is at most $3000. (In fact, under very mild assumptions, which almost always hold, the loss is surely less than $3000, but we won’t need to know that here.)

2. Existing American consumers — the ones who were going to buy those 1000 widgets anyway — pay $6 per widget instead of $9 per widget, and therefore collectively save $3000.

3. Some Americans who were unwilling to buy widgets at $9 will happily buy them at $6, and will be happy with their purchases. This is an additional gain to Americans.

Bottom line: American producers lose at most $3000. Existing American consumers gain $3000. New American consumers gain something too. Therefore the gains to Americans must exceed the losses to Americans.

Continue reading ‘Trumponomics’

Bob Murphy objects to my recent defense of Jonathan Gruber. I have two questions for Bob.

Suppose a newly elected Republican president wants to exempt all investment income from taxation. There are two ways to do this:

1) Retain the income tax, but exempt all interest, dividends, and capital gains (while also abolishing the corporate and estate taxes).

2) Scrap the income tax and replace it with a national consumption tax.

The president’s chief economic advisor, like all economists, is well aware that these two policies are essentially equivalent in the sense that, once prices, wages and interest rates adjust to the new policies, each individual taxpayer is burdened exactly as much by policy 2) as by policy 1). More precisely, at least following an initial adjustment period each individual taxpayer enjoys exactly the same lifetime stream of consumption under policy 2) as under policy 1).

Let’s suppose also that the chief economic advisor believes that policy 1) is vulnerable to scurrilous class-warfare-themed attacks and therefore cannot be sold to the American people. Policy 2), however, stands a chance of passage. He therefore goes around honestly touting what he perceives to be the clear virtues of policy 2), choosing not to mention that it’s equivalent to policy 1).

Continue reading ‘Two Questions for Bob Murphy’